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Thursday, December 11, 2014

The oil price has fallen by more than 40% since June, when
it was $115 a barrel. It is now around $60 per barrel

Ok, this is
something we haven’t heard of much in the recent past but surprisingly oil
prices have been going down for quite some time now. In fact, even our
Government has gone ahead and reduced the price of Petrol and Diesel to pass on
the price reduction to the common man. So, what caused this? The purpose
of this article is to help you understand WHY. I have tried to keep things as
simple as possible.

Before we
Begin - How Oil Price is Determined

The oil price is partly determined by actual supply and
demand, and partly by

expectation. Demand for energy is closely related to
economic activity. It also spikes in the winter in the northern hemisphere, and
during summers in countries which use air conditioning. Supply can be affected
by weather (which prevents tankers loading) and by geopolitical upsets. If
producers think the price is staying high, they invest, which after a lag
boosts supply. Similarly, low prices lead to an investment drought. OPEC’s
decisions shape expectations: if it curbs supply sharply, it can send prices
spiking.

So, what is Resulting in this Free-Fall in Oil Prices?

There are actually 5 main reasons why the oil prices are
falling.

Reason 1: Low Demand

With rising oil prices, most countries are trying to
switch to sources like hydro power or solar. On top of this, most Governments
have stopped subsidizing oil prices as a result of which, in spite of the fact
that crude oil prices are going down, the actual price of Petrol or Diesel hasn't gone down much.

India is a classic example. India’s Diesel Demand was
growing by an average of about 8-10% every year between 2008 and 2012. But, in
Jan 2013, our government started cutting the diesel subsidy. As a result, the
diesel consumption has actually stopped growing at that rate and demand has
come down. Similar is the situation in many other large oil consuming Asian
countries like Indonesia, Thailand, Malaysia etc…

Reason 2: Weak Economic Forecast

Though we are not moving toward an actual Recession, the
economic growth forecast for the next few years isn’t very bright. The
International Monetary Federation – IMF has lowered the Growth Forecast for the
European Union to be around the 1% mark for 2015. With a similar situation in
many other major markets like the US and Japan, the economy does not look so
great.

Reason 3: Libya is back on its feet.

Everyone knows that Libya has been reeling under
tremendous political turmoil especially after the Gadaffi situation. However,
people did not expect them to recover so quickly. During the turmoil they were
able to produce around 200,000 to 300,000 barrels of oil each day. However,
they fixed their problems and have gone up above 800,000 barrels a day and the
supply of oil in the open market is not a problem any more.

Reason 4: The US Oil Production Boom

Everyone knows that the USA is one of the worlds largest
consumer of oil. However, what many people don’t know is that, they have also become
the world’s largest oil producer. They are producing more than 1 million
barrels of oil daily. Though it does not export crude oil, it now imports much
less, creating a lot of spare supply.

Reason 5: Saudi Arabia, Kuwait and other Gulf Countries

It’s a widely known fact that Saudi Arabia and Kuwait are
two of the worlds top oil producers. They and a few of their Gulf allies have
decided not to sacrifice their own market share to restore the price. Most Gulf
Countries can tolerate lower prices because it costs about US$ 5-10 to produce
a barrel and they are still selling it at a hefty price in the market. They
could curb production sharply to hike the price of oil, but the main benefits
would go to countries they don’t like (Example: Iran and Russia).

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